IHFL's real estate exposure a challenge for merger with Lakshmi Vilas Bank

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A public apology issued by Managium Juris LLP, a law firm run by Kislay Pandey for a petition he filed against Indiabulls Housing Finance (IHFL), took the latter’s stock price up by over 13 per cent on Tuesday.

The development is important, given that it clears the air regarding allegations of a Rs 98,000-crore of public money being misappropriated by the company. The petition was filed in June with the Supreme Court of India.

The apology is also important from the perspective of IHFL drawing closer to its proposed merger with South-based Lakshmi Vilas Bank (LVB). Announced in April this year, IHFL, in its presentation, mentioned that it satisfies the critical conditions required to merge with LVB.

From a regulatory perspective, satisfying the fit-and-proper conditions of the Reserve Bank of India (RBI) is extremely critical to get a go-ahead for the deal. However, the finer minutiae of the fit-and-proper clause are subject to the regulator’s discretion and it is understood that pending lawsuits and investigation wouldn’t be seen in a favourable light for those seeking a banking licence.

Likewise, the RBI doesn’t view high exposure to specified sectors, namely real estate, securities and commodities positively. The Indiabulls Group is working on reducing group-level exposure to the real estate sector, with its promoter Sameer Gehlaut attempting to make an exit from the real estate business. But what could be a larger issue for the IHFL–LVB merger is the proportion of loans to the real estate sector on the books of both entities.

Of the Rs 1.13-trillion loan book of IHFL, about 16 per cent is classified as corporate mortgage loans. This number has reduced from 19 per cent a quarter ago as the housing financier sold down/refinanced assets worth Rs 6,005 crore in the first quarter (Q1) with banks and private equities. Yet, at 16 per cent, it is significantly higher, compared to the levels maintained by private banks.

LVB’s share of developer loans stood at 6 per cent, based on 2018-19 financials. “The combined share of the real estate sector exposure may work out to over 20 per cent for the merged entity. Given the RBI hasn’t been very comfortable with banks having higher exposure to the sensitive sectors, the concentration risks appear quite high if the merger goes through,” says an analyst.

Analysts at Morgan Staley also air similar concerns. In a post-results note, they emphasise that regulatory approvals will not be easy for the potential merger with LVB. As there is little track record for the RBI’s licence approval for entities with interest in real estate and capital markets, investors should await the RBI’s approval for IHFL’s merger, the brokerage highlighted in an earlier note.

The proposed merger was initially seen important for LVB whose tier-1 capital slipped to 4.46 per cent in Q1, from 5.72 per cent in March quarter and is well below the regulatory requirement of 7 per cent. However, after the Q1 numbers, with IHFL’s loan book shrinking by 10 per cent year-on-year and net profit by 24 per cent (both falling after many years), the merger seems equally important for the housing financier. Also, with overall borrowing, including bank loans, reducing by 7 per cent since September 2018, analysts point out the urgency to diversify its liabilities profile — an exercise that would be easier done with the merger.

IHFL expects to hear from the RBI on the merger in 45–60 days. Until then, analysts say investors may be better off staying on the sidelines, even if IHFL’s stock has corrected over 57 per cent since April 5 when the merger was announced.

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